Seeing Red

Hey Traders,


I told you yesterday there was a good chance the Option Pit VIX Light would turn red …


Well, it did.


Remember, four sub-indicators inform the VIX Light. They are VIX Curve Formation, VIX Correlation, VIX Volatility and VIX Option Implied Volatility.


Let’s see what they told us …


VIX Curve Formation
This indicator is red when VIX is in a contango, with future prices higher than spot prices …


As you can see on the chart below, the VIX is trading at a discount to the front month contract, the front month contract is trading at a discount to the second month, and so on.



VIX Correlation

The VIX is also negatively correlating with the S&P 500 Index (SPX) … 


SPX did nothing on Wednesday, yet the VIX was down 2.65 points to below 23.


The fact the SPX was only up a touch and VIX got smoked is extremely bearish volatility. The market thinks the SPX is going to stay slow, which always puts pressure on VIX, absent some sort of event risk.


VIX Volatility
Elsewhere, VVIX (the VIX of the VIX) got worked again:



At 111, the VVIX is still high (which means we have to be smart about how we trade; I’ll explain in a bit), but it is tanking.


If the VVIX is falling or stable, that is a red light.


VIX Option Implied Volatility
Finally, there is VIX momentum.


The VIX dropped a bunch, but the Feb VIX future stabilized a touch:



Its movement is slowing as it drops. Red light!


Now What?

That’s FOUR red lights among the indicators, which gives us an overall red Option Pit VIX Light.


One of the reasons I like the simple light system is that it tells me what to do so clearly.


When it’s green, I want to be long VIX …


When it’s yellow, I know I’ll be trading up AND down …


And when it’s red, I know I want to lean short volatility.


(The Option Pit VIX Light is also great for setting up my hedges and for trading in our Volatility Edge product.)


So what does this mean for trading right now? Is there free money to be made?


No … but there is a TON of opportunity!


In general, contango is going to be a problem for VIX bulls.


Every day there is going to be a little bit of air let out of the balloon that separates the VIX and VIX futures.


This puts pressure on VIX, VXX and UVXY (the Ultra VIX Short-Term Futures ETF).


A straight short position in the futures or the exchange traded products (ETPs) is likely to pay.


But an option position is a little trickier.


Remember VVIX — the cost of VIX, VXX, and UVXY options — is still pretty high.


By the time the VIX gets to 21 and the Feb future to 22 or 23, the VVX is going to be between 90 and 100.


So you can’t just buy puts unless they are deeply in the money (I mean 90-100 delta options).


But a trader can spread.


My trade I wrote about yesterday played out perfectly.


There I set up a bearish play in the VIX options themselves. I bought the 25 put and sold the 23 put for about .80.


The VIX 25 puts picked up value (not as much as our pricing model would have predicted because the volatility component dropped) …


But the 23 puts, which were a 15 delta, only picked up about .15 on a drop of 2 points (they should have picked up .30).


So the volatility exposure from the volatility loss in the VIX Feb 25 puts was muted.


Now, how am I playing it going forward?


The same way I played it yesterday.


That means short put spreads and put butterflies in the VIX, VXX and UVXY. (Again, a great place to utilize Volatility Edge.)


This approach will mute the VVIX dropping while taking advantage of the drop in the VIX futures themselves.


I think we are FINALLY set for a sub 20 VIX now that the GameStop Saga of ‘21 has played out.


The Option Pit VIX Light is Red — and short volatility is the go-to play


Your Only Option,

Mark Sebastian


Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.